Written by The Investor
9 April, 2020
– Denial is gone as reality bites.
As the world embraces support packages not seen since wartimes, all of us are beginning to realise the seriousness of Covid-19. There is still much uncertainty as to the length and depth of this pandemic. Some countries are now fearing a return of infection post containment while others are still dealing with ‘curves’ that are accelerating, not flattening. Many are rightly fearful of what is coming since no one knows how bad it could be and how long the disruption will last.
Denial is gone as reality bites
Most importantly the denial is almost gone. Even President Trump now says to expect 100,000–240,000 deaths or more. It’s going to get worse before it gets better in many parts of the world and there will be changes as a result of this virus. Current modelling of Covid-19 suggests almost 82,000 deaths in the US by August 2020. Clearly this puts public health and safety objectives ahead of economic objectives and creates a world with many legacies.
As globalisation fades and debt mounts, stagflation emerges
The age of ‘shareholders first’ and ‘globalization’ may be behind us and it may take many years for the share markets to regain their old highs. Property markets are yet to see the impact of the virus but will be materially affected as time rolls on. The two key drivers of Australian property are employment growth and immigration. Whilst interest rates are low and attractive both these drivers are firmly under question presently.
“The world that emerges after Covid-19 will be different to that which occurred BC. After the Crisis, we expect global (USD) inflation to creep higher, globalization to be dialled back, stock buybacks to be rare / prohibited, and corporate taxes to be higher.” says Hunt Economics.
Short term the central banks will continue to keep interest rates close to zero and it is likely that they will be slow to unwind these policies potentially at the expense of inflation. Post the pandemic there is now talk about stagflation – inflation and stagnant growth – as the world comes to terms with the piles of debt created by the bail-out.
Bonds and financials to underperform from here
Expect the 2020s to be a difficult decade for fixed income markets as the world attempts to inflate away the costs of the Covid-19 War and interest rates shift upwards from zero.
Source: Hunt Economics
In a relative sense the financial system is underperforming the broader share market and suggests that banks are already being priced for slower growth and weaker profit margins.
World growth to be down 10-15% in 2020 and looking L shaped
Morgan Stanley is now predicting between a 38 percent and 45 percent drop in US GDP for the second quarter, after a small drop in the first quarter. Even with the rebound in their moderate case, they still project a 4 percent-plus year-over-year recession in 2020. They acknowledge it could be much worse.
In the bear case outlook, the contraction in 2Q GDP is sharper, and disruptions from the virus persist into 3Q. In that scenario, we see 2Q GDP contracting as much as 45 percent, followed by a soft 3Q, and a rebound in activity in 4Q20 and into 2021. Even with the rebound, the level of output at the end of 2021 in the bear case remains 11.5 percent below its pre-recession peak. They forecast US real GDP to contract 10.7 percent in 2020 and modestly grow 1.2 percent in 2021.
So… the short-term guestimate for Global GDP is minus 10-15 percent with slow growth in 2021. This looks like an L-shaped recovery not the V-shaped or U-shaped recovery many have previously touted.
Constraining the recovery will be massive unemployment and the consequential loss of consumer confidence and with low consumption, as well as massive government debt and rising inflation.
A systematic failure has been averted, but with significant legacies
The Fed has succeeded in preventing a systemic failure in the US financial system. It has put cash into the real economy for companies whilst governments around the world are announcing package after package to help people, businesses, and society in general.
Source: Hunt Economics
The tricky part will be mastering the trickle-down effect and ensuring funds reach people and companies in need so they can survive, then recover. This is still a big unknown in many parts of the world including Australia where many positive packages are now meeting the red tape of Centrelink, the ATO and the banks themselves. Some banks are inserting their responsible lending guidelines across crisis relief loans which seems contrary to the original intentions of government – push cash out to those in need so they are there for the recovery when it comes.
Society, trade and investing have entered a new and uncertain phase
Epidemiologist James McCaw says it appears the peak is either passing or has passed in Australia. Professor McCaw of Melbourne University said how to move forward in the long term was an issue the world needed to grapple with.
“Even if we eradicate the disease in any given country such as Australia, we know that there is an epidemic spreading (somewhere) around the world,” he said.
“It’s almost implausible to imagine this virus going extinct globally, which means that it will be here to stay.”
“The real question is how do we transition to a world where the virus is part of everyday life.”
Short term, there are many challenges to overcome and consequentially investment in shares will be a trader’s market. Whilst it is still unclear where the virus will end it is pivotally unclear where the economics will land. To this point it is fair to assume that interest rates will remain low, share markets will be volatile and only for the skilled traders, and property markets will be quiet with downside risks depending on the shape of the recovery – U or L.
We suggest a prudent wait and see approach until there is clarity around the bottom rather than buy on dip as many have become accustomed to over the last thirty years.
Please consult your advisor for specific recommendations. This general advice does not take into account the client’s objectives, financial situation or needs as we do not and cannot provide personal advice. Any views written about in this article are the views of the author who has no holdings in those companies or investments mentioned in this article.